NY futures extended their rally this week, as May advanced another 331 points to close at 85.12 cents.

It took the market just thirteen sessions to rally more than 800 points and to post a new contract high close this week. Trading volume has been heavy, but open interest has seen almost no change since last week. May open interest is down only 1,298 contracts, while July open interest has dropped just 731 contracts over the last five sessions.

The latest on-call report shows that mills still haven’t made any progress with their fixations. In fact, unfixed on-call sales in current crop went up by 0.12 million bales to 7.77 million bales last week, of which 3.30 million are on May and 4.47 million bales are on July. While mills are fixing some of their existing sales, new ones are being added every week, which has kept the total steady.

The CFTC spec/hedge report of February 27, which is already a bit dated because the market has since gained another 300 points, tells us that speculators were 8.25 million bales net long (up 1.18 million bales), while trade shorts were at 16.25 million bales net short (up 1.30 million bales). Index funds accounted for the remaining net long of 8.0 million bales (up 0.12 million bales).

In other words, for every spec net long there are two trade net shorts. This could lead to a problem, since there are still 7.7 million in unfixed on-call sales on May and July that need to get squared away over the next three months. Will speculators offer enough sell-side liquidity to accommodate these mill fixations?

Today’s US export sales report surpassed all expectations, as 648,300 running bales of Upland and Pima cotton were sold for both marketing years combined. There were 19 markets participating in the buying, while exports of 551,300 running bales went to 30 different destinations. This strong shipment number is proof that the US is capable of shipping more than half a million bales a week, despite all the problems on the logistical side!

Total commitments for the current marketing year have already reached 14.5 million statistical bales, of which 6.8 million bales have so far been exported. If shipments were to average 400k over the remaining 21.7 weeks, then total exports would reach 15.5 million bales by the end of July.

When we look at the US balance sheet, we started with a supply of 23.75 million bales (2.75 beginning stocks + 21.0 million crop), of which 17.85 million bales, or 75%, have already been committed (14.5 exports + 3.35 mill use). This leaves around 5.9 million bales for sale, with about seven months to go before new crop arrives.

We expect most of the remaining cotton to be sold by late summer, as merchants keep pushing sales in order to escape the lack of carry and the inevitable drop to new crop pricing. This push by merchants creates a bullish feedback loop, because when a basis-long position is sold, the corresponding short futures hedge is no longer needed, which puts upward pressure on prices.

Today’s WASDE report was seen as neutral, showing slightly supportive US numbers and mildly bearish world numbers. US ending stocks went down by 0.5 million bales to 5.5 million bales, while ROW stocks increased by 0.2 million bales to 47.9 million bales. The main reason ROW stocks went up was a 0.73 million bales increase in Sudan’s cotton production.

So where do we go from here? Trade shorts seem to be in trouble, because the chart looks strong and fundamentals are supportive as well in view of the strong export performance. Speculators are bullish and have room to add to their net long position, which is still 2-3 million bales shy of its previous peak, while the trade needs to buy back a sizeable portion of its net short over the next three months. Who is going to provide the selling?

If prices go much higher it might lead to some buybacks or cancellations, but we don’t see that as a threat just yet. And even if some cotton were to get freed up again, it would only cover a small portion of the short position that exists at the moment. It will take a lot more than 87k of certified stock to change the mindset of the market. During the March 2008 squeeze the certified stock amounted to 600k, but that wasn’t enough to stop the bullish dynamics that were in place.

Trade shorts are still hoping for spec longs to capitulate at some point, but we view the odds for that to happen as quite slim at the moment. The best the shorts can hope for is for the market to stay range-bound in the low-to-mid 80s, but time is not on their side and the odds for a blow-off move into the 90s are increasing.

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